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Are There Tax Incentives for Individuals to Convert Their Employment Contracts to Partnership Agreements?

The 2017 tax act (Pub. L. 115-97) introduced new §199A,
which provides deduction for individuals engaged in a qualified trade or
business through a partnership, S corporation, an LLC or sole
proprietorship.

The deduction equals to 20% of the individual’s qualified
business income derived from qualified trade or business, which includes any
business other than the trade or business of performing services as an employee
or a specified service business involving health, law, accounting, athletics
and financial services. The amount of the deduction cannot exceed the amount
resulting either from 50% of the wages paid by the business or 25% of wages
paid plus 2.5% of the business’s property used for deriving income. However,
the limitation and the specified service business exclusion do not apply to individuals
who make less than $157,500 (or $315,000 for a married couple).

The new provision may provide an incentive to rearrange employer-employee
relationship to one in which there is a partnership with the original partnership
under a partnership agreement in which the individual’s income from the
partnership can be eligible for the §199A deduction. However, there are reasons
not to do so, because the deduction does not apply to certain §707 payments for
services and excludes highly paid individuals providing the specified business
services. Also, while favorable qualified business income treatment also might
be obtained by converting the employment relationship to one in which the
service-provider is an independent contractor, this potentially leaves the
partnership open to an IRS employment tax audit.

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